Cognizant Technology Solutions Corporation — Q2 2009 Form 10-Q
Business context and reporting period. Unaudited results for the quarter and six months ended June 30, 2009, compared with the corresponding 2008 periods. Cognizant provides IT consulting, technology services and outsourcing, with delivery operations concentrated in India. Amounts below are in millions except per-share data.
Financial performance
| Metric | Q2 2009 | Q2 2008 | Six months 2009 | Six months 2008 |
|---|---|---|---|---|
| Revenue | $776.6 | $685.4 | $1,522.5 | $1,328.5 |
| Operating income | $151.7 | $119.7 | $289.8 | $231.4 |
| Operating margin | 19.5% | 17.5% | 19.0% | 17.4% |
| Net income | $141.3 | $103.9 | $254.4 | $205.7 |
| Diluted EPS | $0.47 | $0.35 | $0.85 | $0.69 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $226.3 | $97.0 |
Q2 revenue grew 13.3%, operating income 26.7% and net income 36.0% year over year. For the first half, revenue grew 14.6%, operating income 25.3% and net income 23.7%. Management cited customer expansion, new clients, outsourcing demand and operating efficiencies. The weaker U.S. dollar against the Indian rupee benefited operating margin; management estimated a 380-basis-point Q2 benefit and a 284-basis-point first-half benefit.
Management’s non-GAAP operating margin, excluding stock-based compensation and Indian stock-related fringe benefit tax, was 20.8% for Q2 and 20.5% for the first half, versus 19.8% and 19.7%, respectively, in 2008. These are non-GAAP measures; stock-based compensation remains a recurring expense.
Business segments. Q2 revenue grew 24.2% in Healthcare, 23.9% in Manufacturing/Retail/Logistics, 5.9% in Financial Services and 7.3% in Other. Financial Services remained exposed to weakness in the global economy and financial sector. IT outsourcing revenue grew 19.4% in Q2 and 21.5% in the first half; IT consulting and technology services grew 6.6% and 7.0%, respectively.
Financial position and liquidity
- At June 30, 2009, cash and cash equivalents were $860.4 million; short-term investments were $122.8 million; working capital was $1,373.8 million.
- Total assets were $2,673.3 million and total liabilities $405.6 million. No borrowings or debt balance is listed in the balance-sheet information provided.
- First-half operating cash flow was $226.3 million; investing activities used $120.4 million and financing activities provided $10.1 million. Cash increased $125.3 million to $860.4 million.
- Trade and unbilled receivables rose to $553.1 million and $82.8 million, respectively. Days sales outstanding, including unbilled receivables, increased to 74.5 days from 70.8 at year-end 2008.
- Investments totaled $283.6 million. Auction-rate securities had failed auctions since February 2008; $142.1 million was classified as such securities, including $136.1 million long term. The UBS Right, valued at $24.7 million, provides an option to sell the securities to UBS at par during June 2010–July 2012. Management said liquidity was sufficient for planned operations, but recovery could take as long as the securities’ final maturity if UBS cannot perform.
Outlook, commentary and risks
- No specific revenue or earnings guidance is stated. Management expected to reinvest 2009 profitability above its historical 19%–20% non-GAAP operating-margin target and forecast global capital expenditures of $130–$150 million for 2009.
- Management expected negligible wage inflation in India in 2009 and planned continued investment in Europe and Asia Pacific, BPO, infrastructure management, customer growth and selective acquisitions.
- Management identified recessionary conditions, financial-services weakness, pressure on customer IT budgets and currency volatility as risks. It expected clients to prioritize cost-containment work, but discretionary project delays or reduced spending could weigh on results.
- Most Indian software-technology-park tax holidays were scheduled to expire March 31, 2010. A proposed one-year extension was not enacted; absent an extension or replacement incentives, management expected a significant increase in the effective tax rate beginning in 2010. The Indian government also proposed repealing the stock-related fringe benefit tax; that proposal was not yet enacted.
- Currency movements materially affect margins and reported results. The company had $568 million notional of rupee cash-flow hedges and $175 million of undesignated foreign-exchange contracts; its sensitivity analysis estimated a 10% exchange-rate movement could change contract fair value by about $75 million.
- Other notable exposures include auction-rate investment valuation and liquidity, customer concentration and contract termination, fixed-price project cost overruns, talent and immigration constraints, India-related geopolitical and regulatory risks, and potential claims involving client-system failures or data disclosures. Fixed-price contracts represented 29.6% of first-half revenue. Management said ordinary-course legal matters were not expected to have a material adverse effect.
- Disclosure controls were assessed as effective at June 30, 2009; no material change in internal control over financial reporting was reported during the quarter.
Most important facts for investors to verify
- Whether the Indian STP tax-holiday extension and proposed fringe benefit tax repeal became law, and the resulting effect on taxes and reported margins.
- Collection trends and receivables: DSO rose to 74.5 days, while unbilled receivables increased to $82.8 million.
- Liquidity and valuation of auction-rate securities, including the assumptions behind the Level 3 valuations and UBS’s ability to honor the UBS Right.
- How much of margin improvement reflected currency benefits versus sustainable operating efficiency, and the treatment of recurring stock-based compensation in non-GAAP comparisons.
- Demand, pricing and concentration risks in Financial Services and the broader recession, along with execution and cost risks from fixed-price contracts and planned capacity investment.